FHA203(K) Renovation Mortgage

Let’s face it. Some homes are in need of love and care, whether it’s a cosmetic face-lift in the kitchen, an upgraded roof or a major structural renovation. Investing in a fixer-upper can be intimidating, but, at a time when housing is increasingly expensive, it may be the only way for a prospective homeowner to afford the home they want.

The government-backed 203k Rehab Mortgage Insurance Program is designed to help with those needs, by incorporating home improvement funds into a single loan for home purchase or refinance. According to the U.S. Department of Housing and Urban Development (HUD), between 15,000 and 17,000 people take advantage of the 203k program each year.

In this post, we’ll talk about how 203k loans work, as well as the pros and cons.

 

The basics of 203k loans

The Federal Housing Administration created the 203k program to give homebuyers or homeowners seeking to rehabilitate a home access to a process that is simpler and less costly than what’s available on the private market.

How it works. In the 203k program, borrowers get a single loan to cover a purchase or refinance and the cost of rehabilitating a home. A portion of the loan is used to purchase the home or pay off an existing mortgage, and the remainder is placed in escrow to cover the work on the home. A single payment plan and set of terms cover both sets of funds. A 203k can be a fixed- or adjustable-rate mortgage.

Like all FHA programs, the U.S. government doesn’t lend the money directly, but provides insurance for the lenders. This process encourages mortgage providers to lend money to people they might not otherwise approve.

How much you can borrow? With a 203k loan, the amount you can borrow is based on the home value after renovation. This is important as it gives you access to more cash upfront. The FHA calculates the amount available either by calculating a percentage of the current value plus the cost of repairs and extra charges, or by taking 110% percent of the assessed After Improvement Value. The loan is also limited by FHA’s Nationwide Mortgage limits.

203k loan rules

There are two versions of the 203k program — Standard and Limited.

The Standard 203k program can be used for repairs over $5,000.

The Limited 203k program is designed for more minor repairs and remodeling. The total cost of the work must not exceed $35,000 and no structural work is allowed.

No matter which program you choose, the borrower must be a primary resident of the home, though as long as they live there they can renovate up to a four-unit home. The loan cannot be used to renovate investment-only properties.  Projects can range from cosmetic to the comprehensive.

What sorts of repairs are covered?

The 203k program covers a really wide range of home improvement or renovation work on homes that are older than one year.

The Limited Program has more restrictions. Any work that will take more than six months is not allowed, nor are repairs seen as a major or structural. Repairs in the limited program are capped to $35,000.

Neither program allows what they call “recreational or luxury improvements.” This includes home improvements like installing a hot tub, tennis court or barbecue pit.

According to the FHA, types of work allowed on the standard program include:

  • structural alterations
  • modernization and functional improvements
  • elimination of health and safety hazards
  • appearance upgrades
  • replacing plumbing, installing a well or septic system
  • adding or replacing roofing, gutters, and downspouts
  • adding or replacing floors
  • major landscape work
  • enhancing accessibility for a disabled person
  • making energy conservation improvements

Who’s eligible for a 203k loan?

The eligibility requirements for  borrowers are the same as for a regular FHA loan. If your credit score is above 580, you are eligible for an FHA loan with a down payment of only 3.5%. If your score is 500-580, you need to put down 10%. You also can’t be delinquent on an existing federal loan.

Pros and cons of a 203k

Pro: You don’t have to pay for renovations out of pocket. The biggest advantage of the 203k is that it often allows people to borrow more money to cover a renovation than they might be able to get on the private market. Without the program, a first-time homebuyer who wants to renovate might not be able to, because they don’t have enough savings and/or can’t get approved for a second loan.

Pro: Access to more financing. The 203k program permits financing against up to 110% of the home’s value after rehabilitation, whereas a normal second mortgage usually caps out at 85%-90% of the pre-renovation value. This way borrowers have access to more cash for their planned work on the home.

Pro: Rates may be lower. FHA loans tend to have more reasonable interest rates than other loans, but there are added fees to cover extra inspections, title updates and the FHA consultants. However, getting a second mortgage will also lead to added fees and closing costs.

Con: The rule book. The loan program also has a lot of rules. Borrowers must be primary residents and the amount they can get is subject to FHA borrowing caps. These vary region by region, and can stop you from buying a home on the high end of the market. You may also have to work with a consultant.

Con: The level of work required. The process is also more involved than the standard mortgage. It is like taking “active participation” from the borrower, who needs to work with the lender to ensure the borrowing and renovation all work in compliance with FHA rules. An experienced lender is a big asset and will help you navigate the process.

How to get a FHA 203k rehab loan

In order to get an FHA 203k, you need to work with an FHA-approved lender. We have all the right resources to help you get approved fast with no hassle. Apply here

What does the 203k consultant do?

Borrowers using the 203k standard track must use an FHA-approved 203k consultant. The consultant is licensed engineer, architect or home inspector who will oversee every part of your home rehabilitation from estimate to completion. The consultant serves as a neutral go-between, communicating between you, the contractor and the lender, and filing the regular paperwork required by the FHA.

The idea of the consultant is kind of like a separate project manager. We carry out many of the functions of a construction manager and help borrowers avoid pitfalls in the process.

A good consultant should be an asset for the borrower. He/she will make sure the home meets health and safety requirements, sort out disputes and keep the project on track. They can even fire a contractor if necessary.

The borrower is required to pay for the consultant, according to a fee table set out by the FHA. Fees vary by the size of the project, and range from several hundred dollars to upward of $1,000.

If you get approved for a 203k, the portion of the loan going toward renovation will go into an escrow account. Your consultant is responsible for signing off the release of funds, which will go directly from the lender to the contractor or other service provider.

Summary

If you are looking to purchase or refinance a home that needs work, an FHA 203k is a great option. However, the home must be a primary residence and the loan is subject to FHA lending limits. If you decide a 203k could be the right choice for you, find an experienced lender to walk you through the FHA process.